Senegal Economic Update: Recent growth drivers and the role of agriculture in developing a resilient and inclusive economy

This Senegal Economic Update (SEU) evaluates the recent (2016‐17) growth performance and macroeconomic policies in Senegal, thus providing a basis for the policy dialog with the Government and other stakeholders.

The first section of the Economic Update evaluates the drivers of growth and the macroeconomic framework. Three‐year perspectives are also included, underlining risks and challenges. The second section evaluates the agricultural sector in more detail focusing on the recent evolution of the agriculture sector and on the impact of public sector involvement.

The State of the Economy and Outlook

Senegal’s economy maintained its wide‐based, strong growth in 2016 and the first half of 2017. GDP growth accelerated from 6.5% in 2015 to 6.7% in 2016, positioning Senegal among the fastest growing economies in the African continent. All sectors of the economy contributed significantly to growth in 2016 with services being the sector that contributed the most due to its large size as a share of GDP. Until mid‐2017, growth maintained its strong performance, though at a slightly slower pace (from 6.4% in H1‐2016 to 5.6% in H1‐2017) mainly due to a deceleration in the agriculture sector.

Exports remained the main driver of growth from the demand side, as it continued its rapid expansion due to recent reforms and a robust external demand. The solid performance of exports, which grew on average by 10.5% in 2015‐2016, resulted from stronger foreign demand in addition to structural and sector reforms implemented over the past years. Other demand components performed well, but their role as growth drivers were not as strong as exports. Total investment grew by 8.8% in 2016 (up from 6.3% in 2015) as a result of the investment program adopted as part of the Plan Senegal Emergent (PSE) (particularly transport and energy) as well as policy interventions in specific industries. While the strong import component of investments reduces their short‐term impact on growth, the increase in both public and private investments bodes well for future growth, particularly if the efficiency of public investment can be enhanced. Private consumption accelerated also as its growth rate increased from 5% in 2015 to 5.3% in 2016 thanks to higher income and optimistic expectations about the future of the Senegalese economy.

Data limitations prevent full understanding of the reasons why faster economic growth did not translate into gains in terms of employment and lower unemployment. Despite faster growth, the economy is still showing slow job creation – particularly in the formal sector – which in turn generates an increase of unemployment in a context of a steady increase of labor supply. The unemployment rate, for instance, increased from 15.7% in June 2015 to 16.6% at end 2016. Further research is needed to explain this outcome, but some hypothesis can be advanced as poor employment creation may be caused by: skill shortages, long‐standing structural rigidities in the labor market, and high costs of labor. Unfortunately, data limitations prevent us from empirically distinguishing between these potential channels and examining the causality chain between growth and employment, specifically in urban areas.

In addition to boosting growth, strong exports helped further strengthen the current account balance despite higher imports which were uplifted by total investments. The strong growth of exports outpaced the increase in imports in 2016, boosted by gold, cement and phosphoric acid; these are sectors where significant reforms have been implemented in past years. Higher imports were driven by machinery and oil, which are linked to stronger total investment and energy demand in relation to higher growth. As a result, the trade deficit decreased, and the current account deficit narrowed further, reaching 5.6% of GDP in 2016, almost half of its 2012 level. However, in the first eight months of 2017 (8M‐2017), the trade balance worsened as rising imports driven by machinery and higher oil prices more than offset the increase in exports which were negatively affected by lower fishing production.

On the fiscal side, the balance has improved due to the recent consolidation efforts – but, in 2017, lower than expected revenues and delayed payments reveal a growing fiscal stress. The fiscal deficit of the Central Government shrank to 4.2% of GDP in 2016 from 4.8% in 2015 because of (i) rationalized current spending stemming from the current fiscal consolidation efforts and (ii) higher revenues driven by better collection of custom taxes. This fiscal space has allowed the government to increase public investments, focusing on significant infrastructure and energy projects that are critical for future growth, as commanded by the PSE. Up to 8M‐ 2017, revenues are lower than expected and, as a result, there is emerging information of non‐ quantified delayed payments. The fiscal balance is still estimated to reach 3.7% at end 2017, but delayed payments reveal underlying fiscal tensions.

Public debt has continued to rise because of below‐the‐line treasury operations; and although the risk of debt distress remains low, this situation might change if debt maintains its upward trend. Despite the fiscal consolidation process, public debt maintained its upward trend and reached 60.6% of GDP in 2016 (while a more modest increase to 60.8% of GDP is expected for 2017), mainly due to ”below the line” treasury operations which relate to the financing needs of public entities that are not part of the central government’s accounts. According to the latest IMF‐WB debt sustainability analysis, public debt in Senegal remains classified at a low risk of distress, but indicators of debt distress – such as the ratios of present value of debt to GDP+remittances, and of debt service to revenue – are showing emergent strains with respect to sustainability. Further deterioration would place Senegal in the category of countries that are subject to a moderate debt risk. In the first eight months (8M) of 2017, slightly lower revenues and strong public investment slowed down the improvement in the fiscal deficit, which declined only marginally from an estimated 5.7% of GDP in 8M‐2016 to 5.6% of GDP in 8M‐2017.

Despite a prudent monetary policy at the regional level, inflation, which has recently increased due to pressures stemming from the stronger economy, remains well under control. The improved economic performance has exerted upward pressure on prices. As a result, inflation increased from almost zero in 2015 to 0.8% in 2016. During the first eight months of 2017, inflation increased further to reach 1.9% on average, reflecting continued strong economic activity despite the recent appreciation of the Euro that helped moderate the prices of imported goods and services. Nonetheless, inflation remained under control and below the 2% target set by the regional central bank thanks to the prudent regional monetary policy, exchange rate stability and ongoing fiscal consolidation efforts.

In line with the ongoing growth performance, the financial sector has expanded from a relatively underdeveloped position, but financial inclusion remains a significant challenge. The stock of total assets and deposits held within the financial sector have been growing at healthy rates over the past few years, from 48.7 and 35.7% of GDP in 2015 to 53 and 37.3% of GDP in 2016, respectively. This is in line with the strong overall economic growth, but is also due to the relatively low degree of initial development. Moreover, the sector is relatively stable and liquid, although concerns about the high – and rising – level of loan concentration persist. Meanwhile, digital financial services are spreading rapidly, but remain very limited due to restrictions in the regulatory and institutional framework. Overall, the financial inclusion of households and SMEs remains poor due to low income and high required collaterals. In that context, a new regional strategy to facilitate financial inclusion is currently underway.

Concerning the economic outlook, growth is expected to remain strong over the next years, but the prospects are subject to downside risks. The World Bank projects that real GDP growth could converge to 7.0% in 2019, if the current internal and external conditions continue supporting this trend. Supported by robust macroeconomic fundamentals, Senegal is expected to remain one of West Africa’s top growth performers. Exports would remain a key driver of growth, particularly due to higher exports from the agriculture, fishery and extractives sectors. The government’s commitment to further increase public investment, with a focus on transport infrastructure and energy, is expected to support growth. However, risks can reduce growth expectations. First, the effects of the PSE program could be undermined if projects are postponed, the quality of public investments deteriorates, or reforms do not address key bottlenecks due to non‐technical motivations. Second, and despite recent improvements in competitiveness and diversification, the agriculture sector would continue to be adversely exposed to volatile climatic conditions, particularly if reforms (for instance, facilitating access to land and enhancing the effectiveness of existing subsidies) are not properly implemented. Third, growth could be constrained and the fiscal and external balances could worsen if oil prices rise, mainly due to their impact on energy costs. Fourth, the appreciation of the euro (to which the FCAF is pegged) may constrain competitiveness.

On the fiscal side, consolidation is expected to continue, but the growing public debt and arrears accumulated poses risks to long‐term macroeconomic sustainability and challenges for treasury management. In baseline expectations, consolidation is still expected to drive the fiscal deficit to 3.0% of GDP by 2019 (in line with WAEMU’s fiscal convergence criterion), if tax revenues and public investment stabilize and current expenditures decline further. Public debt would start declining as a ratio of GDP in 2019. However, for this to happen, additional efforts are needed to increase revenues on the one hand, and rationalize expenditures and manage accumulated arrears and below‐the‐line operations on the other hand. Otherwise, the fiscal situation may deteriorate instead, increasing public debt and placing Senegal at moderate risk of debt distress.

On the external front, the projected continued decline in grants and remittances is expected to slightly worsen the current account balance over the projected period, despite a smaller trade deficit. Growing exports are expected to help reduce the trade deficit. However, the projected improvement in the trade balance would be more than offset by the continued falling trend of grants and remittances. The net result would be a slightly larger current account deficit.

The Agriculture Sector

The agriculture sector has played a critical role in the Senegalese economy, but remains vulnerable to weather shocks, which are likely to intensify with climate change. The agriculture sector, grew at an average rate of 3.2% between 2000 and 2016, but volatility around that average was large. The big swings in agriculture growth, which are highly correlated to large changes in the overall growth rates, are mainly the result of weather and climatic hazards which heavily impact pastoralism and rain‐fed crops such as groundnut, millet and other cereals that have traditionally dominated the sector. This suggests that for Senegal to maintain the high output growth attained since 2015, more efforts are needed to protect the agriculture sector against climatic variability and enhance livelihood resilience in rural areas.

The production of key staples has surged in the past few years due to the expansion of cropped areas and an increase in the use of inputs encouraged by public policies. In addition to making efforts to ease financing constraints in partnership with the private sector, the Senegalese government has adopted several policies to modernize and develop the agriculture sector over the past few years. These policies, such as developing the skills and financial capabilities of farmers, subsidizing of high quality seeds, and supporting agricultural mechanization, have helped boost agriculture yields and production, in cereals, horticulture and pulses. Main beneficiary crops include those tagged as priority value chains under PRACAS (rice, onions and groundnuts, with steady increases by 160%, 74%, and 108% between 2013 and 2017, respectively). Continued public support for rice over the last two decades – by increasing investments and implementing reforms in the irrigation management systems and expanding low land (and rainfed) cropping systems – is paying off with higher rice yields, surpassing the African average and closing the gap with the World average. The private sector has contributed to the improvement in agriculture productivity due to the modern processing units that were developed along the Senegal River Valley.

Recent improvements in agriculture output is linked more to stronger input use than to productivity increases, and had a limited impact on job creation. Labor productivity did not improve over time – and even decreased for certain crops – mainly due to a decreasing land‐to‐ labor ratio. In fact, the increase in agriculture output was largely due to an expansion of input use per unit of land, and to a much lesser degree to overall improvements in Total Factor Productivity (TFP), such as innovation and skills. Therefore, to achieve the objective of poverty reduction – which remains prevalent in rural areas – and drive the transformation agenda, total factor productivity, and labor productivity in particular should be significantly improved. This necessitates creating more jobs for the rural workforce (‘move‐out’ track), while supporting farmers to modernize and better connect to the value chains with the ret of the economy (‘move‐ up’ track).

Agribusiness, particularly the emerging horticultural industry, has the potential to boost agriculture productivity and create new jobs. Despite its relatively small size within the economy, the agribusiness industry could play a major role in agriculture development as it would improve the efficiency of farm production and mitigate the uncertainty associated with the lack of post‐production outlets, hence allowing farmers to earn higher returns. In fact, horticulture, which has been growing rapidly over the past few years, could yield several socio‐economic benefits: improve food security and nutrition, increase farm‐nonfarm linkages and empower women by boosting their on‐farm income and off‐farm employment opportunities and consequently reduce poverty rates, particularly in the rural regions. Moreover, the agroprocessing sector needs to expand significantly from its current low base as it accounts for around 5% of GDP, 10% of the total firm revenues with 97% of agroprocessing enterprises making less than $200,000 as revenues per year.

While public policies have helped boost production, concerns about efficiency and sustainability remain; thus the need to redress public spending to productive factors that would help achieve the transformation agenda. Government policies included high public spending on agriculture with less than proportional impact on the added value created in the economy. While three quarters of the budget allocated to agriculture was spent on crops, only half of the agriculture GDP growth stemmed from crop production, thus raising concerns about the efficiency and sustainability of these expenditures. In fact, inputs subsidies have boosted agriculture production but not the overall total factor productivity. For instance, the government’s support to groundnut prices through state‐(re)owned SONACOS has proven ineffective as it distorts competition among players for groundut collection. It is also delaying the modernization and realignment of the groudnut sector to the international markets trends, thus diverting critical government resources that could otherwise support the agriculture resilience agenda and/or strengthen social protection programs in rural areas. In this sense, the government may reorient its agricultural spending from less productive fertilizer subsidies to productivity‐enhancing input factors such as agricultural R&D, climate change resilient technologies and advanced irrigation techniques. This could be paired with well targeted social protection mechanisms to support the poorest rural households.

In order to deepen the reforms in the groundnut sector, the government should anchor a stable policy framework for whole nut exports, including specific protection against swings in revenues. Reforms undertaken by the government since 2014 to liberalize the groundnut market started yielding results, with stronger exports of nuts and new investments in the value chain (storage, deshelling facilities, with significant potential in term of off‐farm employments). However, distortive policies to keep alive a less profitable processing of crude oils segment prevented farmers from getting the full value of expanding to global whole nuts markets. Within that context, a new value chain centered on producing high quality groundnuts for wholenuts exports and confectionery industry is needed. This requires establishing a level playing field for the private sector to invest and innovate in the processing and marketing segments. A key step in this direction would be to privatize SONACOS. Such reforms should address the issue of revenues volatility, including safety net mechanisms when both international prices and domestic production are low.

Several additional steps need to be implemented in order to achieve a sustained rise in agricultural production and productivity. The agriculture sector should be better integrated with other sectors of the economy, starting with the local food transformation industry that frequently uses imported inputs. Senegal should also improve its risk management mechanisms to shield itself against volatile climatic conditions. This can be done by (i) developing sufficient livestock related infrastructure, (ii) improving farmers’ resilience to weather shocks through developing climate‐smart technologies such as high‐yielding, drought tolerant and early‐maturing varieties, (iii) developing irrigation systems to better control water and gradually move away from rain‐fed agriculture, and (iv) improving access to weather forecasts. To improve productivity, a stronger cooperation between research centers and agricultural advisory councils is required to facilitate knowledge transfer. It is also important to reinforce the technical capacity of small farmers in order to boost productivity. Moreover, it is critical to support and encourage the private sector to play a bigger role in the development of agriculture. Finally, efforts should be made to improve the reliability of agricultural statistics by relying more on new information and communication technologies (ICTs), GPS and drones along with adequate estimation methodologies.